A thought experiment about large consumer appliances...
Imagine that you need a new refrigerator.
Maybe your fridge is a little bit old and starting to make some strange noises. Maybe it’s really old and inefficient, and you know it’s costing you a lot of energy to run. Or maybe it’s completely broken and your milk is going bad and you absolutely need a new fridge today.
Now, imagine that you can’t just run out and buy a fridge from Best Buy or Home Depot or your local appliance shop. Instead, you have to schedule an in-home appointment with a local refrigerator technician. You take the morning off work for the appointment, the tech shows up and works for 30-60 minutes and then tells you what’s wrong with your fridge. Maybe it can be repaired, but unless you have a really new fridge or a really minor problem, it’s probably best just to replace it. So, the technician gives you a couple price quotes for new fridge options to install.
You wonder what the actual prices of these fridges really are, so you do a little internet research. You find they cost 60-80% less than what the technician quoted you. It’s frustrating, but you know that paying the extra money is worth it. After all, installing a fridge is really complicated (it takes two trained professionals the better part of a day), and it requires a bunch of equipment that you can’t even buy without a federal refrigerator-installer license.
Plus, if you do it wrong then it can leak poison gas into your home, killing you and your entire family.
Okay, it got a little weird at the end there. Obviously I’m not talking about refrigerators. But allow me to take the thought experiment one step further.
Now, imagine you own a refrigerator installation business. Your techs have the skills and know-how to repair just about any fridge on the market - but when it comes to replacements, you install only Fridge-o-matic brand equipment. You rarely get customer complaints, and when you do have a problem, the brand provides excellent support. Fridge-o-matic has been around since before you even started training as a refrigerator technician, so you’re confident they’ll be able to provide support for the lifetime of the fridge.
Business is pretty good overall, and you make a solid profit on every job. Your main problem is getting new customers. Since every refrigerator installer in town sells extremely similar equipment, it’s tough to stand out in the market. In fact, you spend about 15% of your gross revenue on marketing, and you know your bigger competitors spend even more than that.
Now a new fridge manufacturer, ColdTech3000, calls you up, and wants you to start selling their new refrigerators instead of Fridge-o-matic. These new fridges seem really good, better than anything you’re selling now. And they’re easier to install and maintenance-free. Maybe this is how you can differentiate your business and get more customers!
But then you start to think…does installing this better fridge actually help you? Your customers are perfectly happy with the quality of Fridge-o-matic. It’s unclear how much money you’ll save from the easier install (you’re trained to do difficult installs!), and the lower maintenance requirement will actually hurt your business.
Meanwhile, the reliability of ColdTech3000 is a total unknown for you. The refrigerator industry is full of horror stories of new brands launching and then quickly going out of business due to failing equipment in the field. What happens to you if ColdTech3000 becomes one of these stories? You’ll have a bunch of unhappy customers demanding refunds for defective equipment, with no support from the manufacturer. Your business would be doomed.
Jumping from Fridge-o-matic to ColdTech3000 is obviously a huge risk. And what’s the reward? A little bit more profit margin on your sales? There’s no way it’s worth it.
Okay, back to reality. Hopefully it’s clear to you that I’ve been talking about HVAC, not refrigerators, this whole time. And hopefully this illustrates a few other points as well:
- A high-touch sales process with in-home consultations from technicians would be ridiculous for a refrigerator. It’s only accepted for HVAC because the installation is difficult and the equipment is obscure.
- The HVAC installation industry adds a ton of cost for homeowners. It’s not that they’re ripping anybody off – they simply have very high costs for marketing, sales, high-skill labor, and support.
- The incentive structures facing HVAC installers cause them to shut out new industry players, and even new technology from existing players. This stifles innovation and technical progress, including heating electrification.
These insights are the basis of 2040 Energy’s business strategy.
- No matter how good our product is, we can’t rely on independent installers to sell our product to homeowners. We must take control of this process ourselves.
- Since we’re doing our own customer acquisition, and we’ve designed the product for easy installation and high reliability, an independent installer network has very little to offer us. We can achieve much lower costs by growing our own installation network.
- Since we don’t have to protect the high margins of independent installers and because our product is so much easier to install, we can implement a modern sales approach: low-touch and internet-based with transparent up-front pricing.
In other words: we are going to sell directly to homeowners via our website, and manage the installation process ourselves. No other OEM in the industry operates like this, and they will think we are crazy for doing it. But this plan gives us the best chance for success. And if we are able to execute on it, we have the potential to revolutionize the industry.
On that note, I have one final thought experiment for you:
Imagine now that you are the CEO of Fridge-o-matic. You are in charge of a hugely successful refrigerator brand that has been around for generations. You sell millions of units per year to fridge installers across the globe through a massive sales and distribution network. You have an enormous manufacturing scale and your margins are steady (albeit not very high).
Your board of directors is happy, but you know that trouble is brewing. The upstart competitor ColdTech3000 has been taking market share in a few niche areas. They can’t match your raw equipment prices, but they are undercutting you in the market with an extremely low installation price.
The installers who sell your product are capturing 60% or more of what the homeowner pays, while your research shows that ColdTech3000’s direct installation costs are more like 15%. Meanwhile, they keep lowering their equipment prices as they scale up production, growing their cost advantage even further. Soon, their high-end refrigerators will be cheaper for homeowners than your entry-level models.
What can you do? You can’t force your installer customers to lower their margins – they need those margins to stay alive in the hyper-competitive refrigerator installation industry. You can’t start selling direct-to-consumer, because your existing installer-customers will revolt and jump ship to one of your competitors. And even if you were willing to risk this, you don’t have the organizational capacity for consumer-facing sales and installation – you would need to build it from the ground up (while eliminating your entire existing sales).
The unfortunate reality is that your company is handcuffed to the installer-as-salesperson business model, which has become uncompetitive. It is a classic case of Innovator’s Dilemma: ColdTech3000’s unattractive business model in a fringe market is now inexorably taking over the mainstream, while you as the incumbent can do nothing to stop it.
Fortunately, the stock market hasn’t caught onto this fact quite yet. You quietly sell your shares in Fridge-o-matic, tender your resignation to the board, and retire to a medium-sized villa in Hawaii. You stretch out and relax on a quiet beach, ponder the troubles that your successor will be facing, and take a deep sip of your Mai Tai…
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